"In a networked world, the United States has the potential to be
the most connected country; it will also be connected to other power centers
that are themselves widely connected. If it pursues the right policies, the
United States has the capacity and the cultural capital to reinvent itself."

Anne-Marie SlaughterForeign
Affairs
January/February 2009

"Engles never flew on an aeroplane; Stalin never wore Dacron."

Deng XiaopingThe
EconomistDecember
13, 2008

Merry Christmas, Happy Holiday and a Safe and Prosperous New Year!

In the past year or so, we have watched some of the
oldest and most widely accepted beliefs in the world of finance
tumble. Stability in markets or counterparts or economies is no longer
assumed. Indeed, aggregate economic activity is falling sharply in the US
and around the globe.

Some of the largest banks and financial companies are failed
or nationalized. Markets have fallen and fearful investors are now willing to
pay sovereign borrowers for the privilege of lending these states the very
worthless fiat paper currency which they emit as a means of exchange! A new form of
taxation via the Federal Reserve Board just in time for the holidays!

As the role of the state in the
global economy swells and a new hoard of
political careerists descends upon Washington, the right of individuals to work, accumulate
wealth and hope for better times never seemed more threatened. The bailout
model of political economy followed during the Bush Administration, after all, is about picking winners
and losers. George Orwell wrote in Animal Farm:

ALL ANIMALS ARE EQUAL
BUT SOME ANIMALS ARE MORE
EQUAL THAN OTHERS

But amidst the gloom and doom, we see
signs of hope. We see evidence that individuals and institutions are again
focused on value instead of transient indicators of price. We see fund managers
and individuals alike thinking about the most likely path to ensure the return
of capital rather than the prospective and thus speculative expectation for the
return on capital. We expect to see growing numbers of cash
investors moving to the banquet table of restructuring even as the economic
indicators - and the political response - dominate the headlines in 2009.

While we see the turmoil besetting members of the "bubble in
trouble" club, we also see the grassroots movement to fence off the problems of
high finance moving along nicely below the radar screen. America adapts and
learns quickly. We hear from corporate and non-profit treasurers that they are
paying stricter attention to asset preservation. They are voting with deposits
and direct placements that the volatility and leverage has been trumped by
tangible and sustainable value. Just under the skin, America is as alive as
ever. Look for 2009 to find more people asking "Where's the beef?"

Year-end 2008 is an important date for IRA as well. We have
rolled-out our explicit letter rating grades for safety and soundness calculated
for all US banks and bank holding companies. The A thru F ratings grades
are displayed in both the individual IRA Bank Cart Reports as well
as in all of the profiles in the IRA Bank Monitor professional analytics tool. The result
of several years of work by CEO Dennis Santiago and our development team in LA, the
letter ratings in the IRA Bank Monitor now provide individual depositors, corporate treasurers and investment
and credit managers, actionable tools for measuring the current safety and soundness of
a given depository or group of depositories.

We see 2009 as a watershed year for the
portion of the bank ratings community that is focused on safety and soundness
instead of discredited equity market indicators. The process of asset placement is
about to be a lot more transparent and accountable as good money moves into
strong banks. Users of the IRA Bank Monitor and Bank Cart
tools will notice that the banks which made it onto Sheila's List in 2008 were
all about one order of magnitude above the industry average stress -- that's a score
of 7 or more vs the 1.5 industry average as of Q3 2008. Click here for more information.

In terms of the US banking industry, we
expect to see a continued deterioration in the components of the IRA Bank Stress Index
and with
it a slide in the overall ratings of the industry. There is still a
considerable feedstock of toxic bubble remnants which needs to work its way
through the financial system and there remains the political problem of
admitting to and getting on with the reality that there's no such thing as "too
big to fail."

Through the third quarter, ROE degradation and loan
defaults remain the leading contributors to elevated stress ratings among all US banks.
Institutions with lingering bubble toxin issues will continue to feel the
effects from distended default experience rates as income streams divert into
loss provisions. In 2009, other operating factors such as capital, exposure and
efficiency are going to be more and more prominent in terms of their
contribution to the overall level of stress in the industry.

We see
consumer and commercial credit availability will continue to be squeezed
particularly in larger institutions as they struggle to bring commitment
exposure ratios back into balance. Because of this we see smaller less stressed
institutions as the place where the U.S. credit engine will restart first and
recommend public policy emphasis on this systemic solution path be vigorously
examined. These little birds comprise 2/3'rds of the banking industry; more than
enough critical mass to see the first year of a new President's visions blossom
into true economic recovery.

That said, there are currently 10 banks among the top 20 US
banks by assets that still rate an "A" safety and soundness rating as calculated
by the IRA Bank Monitor. We expect to see these ratings
deteriorate as the next year progresses and, because of their size, to see their
sagas dominate the media even as the real "prime solution" moves along. The
trick in 2009, for depositors and investors alike, will be to objectively
identify which institutions have the greatest Economic Capital risk and thus are
likely to see their nominal current ratings based on the FDIC data move lower as
the economic contraction worsens.

During 2009, the concern among regulators and policy makers in
Washington is going to move from consumer risk to commercial and business risk.
Whereas names such as Citigroup (NYSE:C) were front-and-center of the financial
news during 2008 due to the preponderance of consumer and OBS risk on the bank's
books, the year ahead will see more focus on commercial risks held by names like
JPMorgan Chase (NYSE:JPM) and dozens of other institutions of all sizes with
significant C&I exposure.

One of the most important issues facing the markets and the new
president, Barack Obama, is accounting for the public funds deployed to date and
how to proceed with the economic rescue plan in 2009. We hope that the Congress and
President Obama come together on a plan that puts any additional new
capital into solvent banks and companies, and requires the orderly liquidation and sale of
larger insolvent financial institutions such as C and JPM. The latter still rates an "A" on the IRA Bank Monitor due to its current performance, but the 4:1 ratio between Economic Capital to current tier one equity suggests a rocky road ahead for JPM.

We expect that public revelations about the bailout will be "Topic A" in the new
Congress. As former AIG (NYSE:AIG) CEO Herb Greenberg said on CNBC yesterday morning, the decision by the New York Fed's
Tim Geithner, Treasury Secretary Hank Paulson and other government officials to
bail-out the credit default counterparties of AIG is a matter of pressing public
concern. "Who were these counterparties?," Greenberg rightly asks. "Who would
believe that they would be taken out at par?"

As Bloomberg
News reported on December 17th, AIG may face another $30 billion in
writedowns due to European CDS exposure: "An examination of AIGs credit-default swaps guaranteeing more than $300 billion of corporate loans, mortgages and other assets not covered by a $152.5 billion federal rescue shows the New York-based insurer may value some of its positions at levels that dont reflect distress in the markets, according to an analyst at Gradient Analytics Inc. and a tax consultant who teaches at Columbia University Business School in New York."

In 2009, we predict that the rest of the story will
be told regarding AIG and the bailout of Goldman Sachs (NYSE:GS), JPM and the
other CDS dealers banks orchestrated by
the Fed and Treasury. During the next year, starting with the confirmation process for
Geithner by the Senate Banking Committee, we predict that the Fed is
going to be forced to come clean on the hundreds of bailout loans made so far and
to explain just why this vast expenditure of public funds was justified. When that
explanation is made, then we can really begin the rebuilding process and
start thinking about unwinding the government's position.

In fact, now that the remarkable political economists who
dominate the Federal Reserve Board have pushed the official interest rate
target to zero, the only place to go is up. At some point, we are
confident, even the folks at the Fed are going to realize that a zero interest
rate policy is doing more harm than good to the global markets, like driving the
repo market and many money market funds into extinction. If cash has no time
value, then many financial assets are likewise without any worth. If the
Fed wants to liquidate the assets on its balance sheet near par, it should let
rates rise.

We've said it before and we'll say it again, instead of
worrying about the indicative "price" of credit, our esteemed colleagues at the
US central bank should simply increase money in circulation until Treasury TIPS
start to move in yield. There is a reason why the framers of the Federal Reserve
Act did not allow the Fed to issue debt. Let the Fed start creating money
and slowly buying all types of paper at market prices, and the steep yield
curve will follow in short order. Then a recovery will be well and truly
underway.

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